Findings on Lehman Take Even Experts by Surprise

For the year that it took the court-appointed examiner to complete his report on the demise of Lehman Brothers, officials from Wall Street to Washington were anticipating it as the definitive account of the largest bankruptcy in American history.

And the report did just that when it was unveiled on Thursday, riveting readers with the exhaustive detail contained in its nine volumes and 2,200 pages. Yet almost immediately, it raised a host of new questions.

Now government regulators have what some lawyers call a road map for further inquiry into former Lehman executives like Richard S. Fuld Jr. and the auditing firm Ernst & Young.

Whether the Justice Department and the Securities and Exchange Commission will actually pursue their own legal actions is unclear. But legal experts said on Friday that the examiner, Anton R. Valukas, had provided plenty of material for civil regulatory action at the least with his findings of “materially misleading” accounting and “actionable balance sheet manipulation.”

“It’s certainly not helpful to any of them,” Michael J. Missal, a partner at the law firm K&L Gates and the examiner in the bankruptcy case of New Century Financial, said of some individuals accused of impropriety in the report. “It certainly assists private litigants and probably increases the pressure on the government to take some kind of action here.”

Representatives for the S.E.C. and the United States attorneys offices in Manhattan and Brooklyn declined to comment.

Photo

Men with boxes leaving the Lehman Brothers building after the firm's collapse in 2008.Credit
Joshua Lott/Reuters

While Mr. Fuld and other former top Lehman officials are already defendants in a number of civil lawsuits, the new discoveries by Mr. Valukas have taken even veteran observers by surprise. Chief among these was the revelation of a particularly aggressive accounting practice, known internally as Repo 105, that Mr. Valukas said helped the investment bank mask the true depths of its financial woes.

Examiners in bankruptcy cases are appointed by the Justice Department to investigate accusations of wrongdoing or misconduct. Their job is to determine whether creditors can recover more money in these cases, and their findings often serve as guides for more lawsuits and even regulatory action.

What examiners are not asked to do is play judge and jury. Though the report contains strong language — Mr. Valukas deems Mr. Fuld “at least grossly negligent” in his role overseeing Lehman — it stops short of accusing anyone of criminal conduct or of violating securities law.

Patricia Hynes, a lawyer for Mr. Fuld, said on Thursday that her client “did not know what those transactions were — he didn’t structure or negotiate them, nor was he aware of their accounting treatment.” She did not return an e-mail seeking additional comment on Friday.

Mr. Valukas’s findings have stirred loud discussion among legal and accounting experts over the ways Lehman sought to improve its quarterly results months before it collapsed.

Over hundreds of pages, Mr. Valukas details the genesis of and the process behind Repo 105. Based on standard repurchase agreements — short-term loans commonly used by many firms for daily financing needs, in which borrowers temporarily exchange assets in return for cash up front — Lehman took a particularly aggressive accounting approach to these transactions.

The accounting tactic, first used by Lehman in 2001, had one catch, according to Mr. Valukas: no American law firm would sign off on its use.

Enter Linklaters, a highly respected British law firm that gave Lehman the answer it wanted. So long as the repos were conducted in London through the bank’s European arm, and so long as the company took other cosmetic steps to make these transactions appear to be sales instead of financings, Linklaters determined that they would pass regulatory muster.

A spokeswoman for Linklaters said on Friday that the firm was not contacted by Mr. Valukas and that its legal opinions were not criticized in the examiner’s report as wrong or improper.

Lehman also had the backing of Ernst & Young, which certified the bank’s financial statements despite receiving warnings from a whistle-blower who said there were accounting improprieties. An Ernst & Young spokesman said on Thursday that the firm stood by its work for 2007, the last year it conducted an audit of Lehman’s financial results.

But Lynn E. Turner, a former chief accountant for the S.E.C., accused Ernst & Young of abdicating its responsibility to the audit committee of Lehman’s board by not presenting the concerns.

“This is pretty aggressive and pretty abusive. I don’t know how under GAAP this follows the rules whatsoever,” he said, referring to Generally Accepted Accounting Principles.

“That reeks of an auditor who, rather than being really truly independent, is beholden to management,” he said, adding that the S.E.C. and the Justice Department should follow up on Mr. Valukas’s findings.

Executives at other Wall Street banks professed surprise at Lehman’s accounting maneuvers. Goldman Sachs, Barclays Capital and other banks said on Friday they did not use repos to hide liabilities on their balance sheets.

A version of this article appears in print on March 13, 2010, on page B1 of the New York edition with the headline: Clarity, and More Questions. Order Reprints|Today's Paper|Subscribe